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Abstract
This paper outlines the fundamental arguments of the New Consensus, critiques it from a Post-Keynesian perspective, and offers a Post-Keynesian alternative to the Taylor Rule. While Post-Keynesian economics provides a theory of endogenous money with exogenous interest rates, it has no clear description of a central bank reaction function. We attempt to remedy this oversight by identifying some of the difficulties attached to developing a Post-Keynesian reaction function, and suggesting an approach to the setting of interest rates that is more consistent than the Taylor Rule with Keynes's General Theory.
Acknowledgments
This paper was presented at the Eastern Economic Association Conference, New York, 2005. The authors would like to thank Mario Seccareccia and John Smithin for their comments. Of course, all errors remain the responsibility of the authors.
Notes
1Among those who have examined the smilarities and differences between New Consensus and Post-Keynesian economics we may cite Lavoie Citation(2004), Monvoisin & Rochon Citation(2006), Palley Citation(2006), Rochon Citation(2004), Setterfield Citation(2004) and Smithin Citation(2004).
2Rochon Citation(2004) explores the close similarities between the New Consensus and Wicksell's monetary economics; see also Seccareccia Citation(1998).
3In a more complicated model, which includes the output gap, the MP curve would be an upward-sloping curve in interest-rate/output space. This reflects the fact that interest rates increase not only with inflation, but with growing output as well.
4This statement can be challenged from various standpoints. For starters, how do we define economic performance? Do we, for instance, include income distribution? Usually, proponents of such regimes refer only to inflation. But the low inflation prevailing in many countries today cannot be attributed solely to inflation targeting: inflation had been coming down before inflation targets were adopted. See Rochon & Rossi Citation(2006) for a critical review.
5Bernanke & Gertler Citation(1989), for instance, have shown that investment is positively linked to the firm's balance sheet position, defined as the ratio of net worth to liabilities. If the ratio is high, then there are more resources to use either as internal funds or as collateral to obtain outside funds. Hence, the market equilibrium level of investment will vary positively with the borrowers' balance sheet position, as the net worth of firms increases, and negatively with the rate of interest (Calomiris & Hubbard, Citation1990; Fazzari et al., Citation1988). Bernanke & Gertler (Citation1995, p. 37) have suggested a way of measuring this loss of net worth, by computing what they call the ‘coverage ratio’: the ratio between the interest payments over the interest payments plus profits. They argue that ‘Increases in the funds rate translate almost immediately into increases in the coverage ratio, and hence, ultimately, into weaker balance sheet positions.’ An increase in the rate of interest will affect both components of the coverage ratio: it increases interest payments and it also reduces profits through its impact on costs and revenues.
6In a question and answer session following his key address at a chartalist conference in Kansas City, Goodhart readily admitted that the natural rate is virtually impossible to calculate. Central bankers, he claimed, recognized this yet still insisted on the ‘usefulness’ of the natural rate.
